Inflation is the canary in the coalmine for investors
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There is plenty of optimism around for 2021, despite the latest headlines about the resurgence of the Covid-19 virus in Europe and the US.
Investors look forward to the roll out of vaccines and expect major economies to remove many of the restrictions on social contacts and travel later this year. They confidently expect central banks and governments to keep boosting economic activity, with ultra-low interest rates, plenty of money creation and substantial government borrowing.
Investors are not ignoring the advent of faster-spreading variants of the virus and the leap in cases in the northern winter that has forced governments on both sides of the Atlantic to impose more lockdowns. But they are looking beyond the immediate future to recovery ahead.
2021 is billed as the year of build back better, the post-pandemic government-led investment programmes planned in the US, the EU and UK. Many states and large companies intend to turn general green promises into action to cut carbon in the next few months.
This is not going to be an easy or V-shaped recovery. It will be another year of tensions between the US and China, with the EU drawn more into supporting the US. Russia will continue as a disrupter, consolidating her influence in the Middle East and in eastern European satellite countries. Meanwhile, fierce competitive battles are intensifying in the business world, as digital champions fight to keep the extraordinary market share gains made during lockdowns, and resist government demands for more tax and greater regulatory control.
The FT fund, with its roughly 50/50 balance of shares and bonds, had a good year in 2020, ending with a return of 12 per cent at a time when the UK and European share indices fell during the 12 months. The main US index was up by 15 per cent. Bonds provided positive single figure returns.
The fund achieved this by concentrating its shares on the digital and green revolutions, backing Nasdaq-listed stocks and themed global index funds. These positions have performed so well it was tempting to take profits and do something else. I did sell out some, diverting money into the general world index to have more exposure to broad economic recovery as well as tech. I am sticking with the exposure to the electric energy transformation and internet expansion.
This year is likely again to see a big gap between the gains in winning sectors, and the weaker performance of industries punished by Covid-19 and the impact of the green revolution.
Some hospitality and travel businesses will have a lot of debt to manage. They may need to recapitalise and, in some cases, may not revive. The longer the latest Covid wave lingers the more businesses will suffer.
Others will benefit from a bounce back as consumers who kept their jobs and were unable to spend their marginal income on pleasure return to restaurants and airports when the all clear is eventually sounded. High street retailers and commercial landlords still have bad news to face. Anyone making traditional diesel and petrol cars is in for a tough time even as the lockdowns are lifted.
The fashion for green investing will drive more investors into electrical everything — wind and solar power, battery production and greener transport. Demand for investments may still outstrip supply, as investors rush to find backable entrepreneurs.
Unfortunately, there is a lack so far of popular green products that rush off the shelves or out of the showrooms. For the rich and green, the Tesla cars come close. But with their high price, Teslas are not a people’s car like the VW Beetle or the Austin Mini.
Maybe this year a company will emerge with superstar affordable products that will define the revolution. If so, it will make plenty of money. It must be something as must-have as a mobile phone or tablet computer.
Globally, 2021 will see outperformance by China as it competes with the US for the title of the world’s largest economy. The EU, reduced in size by the UK’s departure, will continue to see decline in its share of world gross domestic product, currently around 15 per cent. The UK should see a good recovery from the hit it took last year, with forecasters expecting strong growth from the second quarter.
Europe remains at a disadvantage to the US and China, thanks to its lack of successful technology giants, such as Microsoft and Google on one side of the Pacific and Alibaba on the other.
Europe also lacks scale in green products. despite its enthusiasm for the green revolution, allowing China to gain a dominant position in batteries while the US is doing well in electric cars and solar power.
The fund is as heavily invested in shares as the balanced rules allow. As the year advances and the economies recover it may be necessary to become more cautious. With the piles of debt, any hint of withdrawal of central bank monetary support would be worrying, as would premature moves by governments to rein in public debt and spending. For the time being the advanced world is running on the Japanese model of borrowing and buying in the state debts with newly created money.
That works just as long as inflation stays down and confidence is retained. I will be watching inflation as the canary in the coalmine. So far we just have asset price inflation. If that started to seep into the cost of living the outlook would turn less rosy.
Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. firstname.lastname@example.org